Shadows of Doubt

Foreboding ‘shadow inventory’ threatens housing recovery

By Sarah Baker

As the housing market continues to improve, a significant backlog of foreclosed and distressed properties that have not been put on the market could bring the recovery to a screeching halt.

Memphis News File Photo/Lance Murphey

Many lenders across the nation – mostly banks – are struggling to keep up with the overwhelming number of borrowers who have stopped making their mortgage payments. And with the fledgling recovery in housing still weak, banks, institutional investors and even some homeowners who want to sell their homes are waiting until the market shows marked improvement.

This “shadow inventory” – the backlog of properties that are 90 days or more delinquent, in foreclosure or bank owned but haven’t yet hit the market – poses a threat to the housing recovery.

“It may well be that the lenders are moderating what comes in by what goes out so that there’s kind of a balance – they’re not trying to dump everything on the market all at once,” said Corky Neale, director of research for RISE, a Memphis-based organization that helps low-income residents achieve financial success.

“The other possibility, too, is that there may be stuff that’s never going to be added to the inventory … (for example) houses that are awaiting foreclosure, where the residents have already moved out.”

Shadow inventory is estimated at more than 7 million properties nationally, about $480 billion, according to the most recent Fitch Inc. data.

That number is not expected to decline soon.

Analysts expect it will take more than 40 months for the distressed properties to even hit the market.

While Memphis’ shadow inventory may not look as grim as in areas like Florida, Michigan or California, it has plenty of room for concern.

Memphis’ shadow inventory count is about 3,200 homes, Neale said.

By analyzing the top 25 inventory holders in 2008 and 2009 versus 2010’s third quarter sales, Neale found a difference between what’s known to be held in inventory and what is available by way of ZIP code.

Neale said shadow inventory will likely grow by 100 to 150 units per quarter due to fewer takers of foreclosed inventory.

Coupled with the threat of rising interest rates and the possibility of mortgage interest payment write-offs for homeowners, the risk of a double-dip recession is rising, said Dr. John Gnuschke, director of the University of Memphis’ Sparks Bureau of Business and Economic Research and co-director of the Center for Real Estate Research.

“If those two things happen, then the housing market will crash again, and that could cause another recession,” Gnuschke said.

Across the board, analysts expect the recovery in home prices to face strong headwinds.

“The weak demand for housing is significantly increasing the risk of further price declines in the housing market,” Mark Fleming, chief economist for CoreLogic, wrote in a Nov. 22 report.

“This is being exacerbated by a significant and growing shadow inventory that is likely to persist for some time due to the highly extended time-to-liquidation that servicers are currently experiencing.”

In September, Memphis recorded the fifth highest percentage of home price reductions – a whopping 35 percent – tying Albuquerque, N.M., and Boston, according to San Francisco-based Trulia Inc., a real estate search engine.

In fact, Memphis-area sales volume took a 3.4 percent dip from $1.39 billion in 2010 compared to last year’s $1.44 billion, according to the Memphis Area Association of Realtors’ monthly MAARdata market report.

The largest amount of inventory MAAR has seen in the Memphis metro area over the last couple of years was in May 2008, when there were 12,641 active listings in the Multiple Service Listing (MLS) as of the middle of the month. May 2008 MLS sales were 1,231, which reached a 10.2-month total supply.

Click to view

To put it in perspective, as of Oct. 15, 9,399 active listings and 717 property sales marked a 13.1-month supply. Nationally through Oct. 15, most homes for sale spent a minimum of 121 days on the market – and those are just the listed homes.

Shelby County’s consistently high foreclosure rate caused the area to never endure the bubble that cities like Miami and Atlanta did. In fact, Memphis has made significant progress since 2006 and 2007, Neale said, when it was consistently making the top 10 list of nationally foreclosed cities.

In Q3, Shelby County saw 1,160 total bank sales, an 18 percent drop from Q2, and a 13 percent drop from Q3 2009, according to real estate information company Chandler Reports, www.chandlerreports.com. Year-to-date foreclosure sales are down 14 percent at 3,821.

“My sense is that Memphis has passed the peak of foreclosures,” Neale said. “But I don’t know if we’re on the downhill slope of clearing out the inventory yet.”

“Last year, most financial institutions with a portfolio of foreclosed homes had learned the lesson that dumping the entire portfolio on the market can have a negative effect on the value of their properties,” Moore said. “(We’re seeing) a more responsible way of bringing their portfolio of homes on the market.”

Indeed, the inventory will be strategically added to the monthly supply of homes for sale over an extended period of time, said Andrew Gibbs, senior vice president of Memphis-based Mercer Capital. And it’s very much a local phenomenon, which is right in line with other real estate market trends.

Tennessee’s non-judicial state proceedings – meaning properties can be foreclosed on in as little as 28 days – are much different than areas like Florida where the heavy backlog of foreclosures enables homeowners to live in their house for a long time before they must turn over the keys to the bank.

Compared to softer submarkets like South and North Memphis, the higher ends of the market’s deterioration and values have not been as adversely affected, so it has more exposure left, Gibbs said.

“I guess in one sense, (the 28 days) kind of controls the shadow inventory in Tennessee versus other states,” Gibbs said. “I think Memphis’ issue is just sort of more of an economic challenge of the region.”

But to Steve Lockwood, executive director of the Frayser Community Development Corp., Tennessee’s permissible four-week foreclosure process is too quick. This rings especially true for submarkets such as Frayser’s 38127, which has been designated by the City of Memphis as a “priority area.”

“There are rushes to judgment that sometimes could have been prevented if there was more time and actually had time for representation for the clients,” Lockwood said. “The truth is, especially in the Memphis market, an awful lot of people can be helped.”

Property values remain a top concern across the board.

“Once they’ve been foreclosed on, there needs to be some way to put them back into the market as soon as possible, otherwise it hurts the neighborhood,” Lockwood said.

Foreclosure is generally the last resort for lenders, said Greg Gonzales, commissioner of the Tennessee Department of Financial Institutions.

“What started out nationally as a subprime issue eventually became engulfed by the economic downturn and unemployment,” said Gonzales.

More than 8 million jobs have been lost during the Great Recession so the foreclosure crisis rapidly spread from subprime borrowers to homeowners with conventional loans as well.

Now many groups are creating test programs that allow delinquent borrowers a six-month grace period if they in turn keep the house in good condition, thus making it easier to sell down the road.

One of the leading proponents of this effort is New York-based Citigroup Inc., a company based in a city that contains an estimated 103 months of supply in shadow, according to Standard and Poor’s.

Even before the job market plummeted, however, there was a moderately high incidence of default, said Webb Brewer, attorney with Memphis-based Brewer & Barlow PLC.

In response, the federal government has made efforts to encourage loan modifications, such as the Home Affordable Modification Program (HAMP), which tries to keep people who cannot afford their mortgage in their home. But Fitch shows a more than 50 percent default rate for homeowners who had their loans modified.

The foreclosure crisis will likely remain a problem until lenders are willing to reduce the principle amount of the mortgage so it is more in line with the property’s actual value, Brewer said.

A significant decrease in the property tax base can be expected as well, said Rand Bouldin, real estate analyst with Bouldin & Associates.

“In 2009, the (Shelby County) assessor was able to continue to look into the past and exclude bank sales and foreclosures,” Bouldin said. “That will be much more difficult as we move forward and new appeals are filed. Any further decrease in values would certainly increase the problem.”

While many people view shadow inventory as mostly a problem for banks and institutional investors, it is really a problem for all homeowners.

“Shadow inventory’s real lasting impact is going to be the loss of equity of (conventional) homeowners, who have continued to make the mortgage payments and continued to live in their homes,” Neale said. n